If cash flow is the lifeblood of a business, than gross margin must certainly be the heartbeat.
Gross margin is the amount left over after subtracting the cost of goods/services sold from the sales price and is what is available to cover fixed costs like rent, utilities, and loan payments and to pay the owner from what is left over.
An entrepreneur should always be looking for ways to increase their gross margin but it is one area that is often ignored.
There are essentially two ways to increase gross margin: increase price or decrease input costs.
Increasing prices may or may not be feasible depending upon customer base, competition from other businesses, or other market pressures.
One way to accomplish a price increase is through differentiation with a value-added service.
An example is pizza delivery.
While it may be difficult to increase the price on a pizza because competition is stiff, it is much easier to pad the delivery charge (which is seldom advertised and not usually a consideration when someone orders a pizza to be delivered) and effectively increase the price on the pizza.
As I mentioned, the second way to increase gross margin is to reduce input costs.
There are a number of ways to reduce the costs of inputs from buying supplies in quantity in order to obtain a larger discount to establishing workflows and processes with employees which increase efficiency.
It is important to remember that no matter what product or service a business delivers, careful consideration should be given to each and every one of the inputs and whether there is a way to reduce their costs.
A final consideration when talking about gross margin is customer mix.
Customer mix refers to categorizing customers based upon the volume of their purchases and the gross margin generated from those purchases.
Customers are separated into four categories: high-margin/high-volume, high-margin/low-volume, low-margin/high-volume, and low-margin/low-volume.
The combined gross margins from each group constitute a business' total gross margin.
The goal, of course is to increase the percentage of high-margin customers, but sometimes a business will focus on serving low-margin/high volume customers because they generate a lot of sales.
Sometimes, a high volume customer will crowd out other customers due to their large orders.
By looking at what percentage each customer category contributes to the total gross margin, a business owner can determine the impact of adding a high volume customer.